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Four Positive Surprises for the Economy in 2012

The U.S. is particularly well situated compared with almost any other economy in the world right now, says Morningstar's director of economic analysis. These four factors should push 2012 GDP growth ahead of 2011's rate.

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Bob Johnson: I'm Bob Johnson, the director of economic analysis. I actually work with the stocks department [at Morningstar]. I actually sit with our stock analysts, and I was a stock analyst for many years, both on the sell side and the buy side, and then most recently I was head of the technology team that followed all the tech stocks and managed a group of people. And I came over to become an economist about three years ago now. So, I come to economics from a base in stocks and the real economy, not with a Ph.D. in economics. So, I come with a view that is maybe somewhat like yours.

So, I hope to give you a better flavor of what's happening in the economy today and try to give you some key points that you can watch in looking at the economy as we go ahead to figure out what's going on on your own. I think there is lot of confusion with a lot of the numbers; the numbers come out almost daily, and they are restated a million times. But if you know what to watch, they kind of have a language of their own. They kind of speak to you, if you will. We'll talk about it.

I hope to try to make this relevant to you. I don't know how many people here are thinking about buying a home? Anybody here thinking about buying a home at all, because we'll talk a little about that and the housing market. I think there is a great opportunity in housing. I think we're at kind of a historic low in terms of housing prices. I don't think they're going to run back up in a hurry, but I think I'll be able to talk to you a little bit about why I think that market is turning, and why I think there may be some good opportunities for you in the housing market.

I also hope to touch a little bit on inflation and pricing and what's happening there.

Then I'll talk about the disconnect that we're seeing in the economy right now. I think the U.S. economy is particularly well situated compared to almost any other economy in the world right now. I think that we're in a great position, but that doesn't necessarily mean that stocks and corporate earnings are going to improve a lot from here, because so many corporations get a huge portion of their earnings overseas, 25% to 30% is not unusual for a Fortune 500 company, and as those markets weaken a little bit, it certainly may hurt their earnings. But the U.S. economy and U.S. employment will probably look increasingly better, just because of things that are already "baked in," if you will.

So, I am going to start out and give you my view of where the economy has been, give you my forecast, let you know exactly where I stand right upfront, so when I come back a year now, you can say, "Bob, you were wrong!" And then we'll go from there to talk about what the key drivers are in the economy, and I'll close with what's the main topic up there, "The Positive Surprises in the Economy," and I think there are a lot of them out there for 2012. I have four I am going to talk about, a couple of them aren't even so much surprises anymore, unfortunately. I've worked on this talk for a while, and in the last 60 days, the surprises have kind of turned into reality a little bit. So, unfortunately, it's taken away some of the surprise, but that's the focus for today. And I hope to have time for your questions. If I am not making myself clear on something, let me know what questions you have as we go along. I'll save time for questions at the end, but if I am not clear, please stop me, and I'll explain myself a little bit more clearly.

So, where have we been? Well, 2011 was a so-so year. For the full year GDP, the gross domestic product, grew about 1.6%. Let me give you a little perspective on that. A typical number is, say, between 2.5% to 3% in booming normal times. Maybe you have a quarter or two of really good growth of 4% to 5% coming out of a recession, but a typical number is 2.5% to 3%. So, the 1.6% was not so good, especially compared with 2.8% that we had in the prior year, 2010.

To give yet another perspective on it, population growth was about 0.7%. So, the economy did grow faster than the population, so that's the one piece of good news in that number that we'll talk about.

Then talking in terms of 2011, some other key factors: Inflation was a big killer in 2011. We had the Arab Spring and the rise in oil prices in 2011. And we saw prices at one point in September get up to almost 4% on a year-over-year basis in terms of inflation, and that hurts. And you all know, even if we do get raises, they tend to come once a year, and you get that 4% jump in inflation, and it really goes right to your bottom line--and especially when a lot of it is oil prices; it's something we use every day, so that really kind of scared people in the mid-year. So that inflation was really a key, unexpected thing that happened in 2011.

Then if we look at unemployment, actually the news there was a little better. We closed out the year at 8.5% for an unemployment rate. We peaked at 10.1% back in 2009. So, we've really brought that number back in. Some of it was people leaving the workforce, but most of it has come from people finding jobs. And just on that whole employment situation, we added about a 174,000 jobs per month on average in 2011. They recently revised that number. It was more like a 160,000, and then they found some more jobs and they went back and counted all the small businesses. So, it turns out the job situation was a little bit better than we all thought in 2011.

So, those are some of the key parameters, as I look at 2011. And again, it was a year that built throughout. We started the year at 0.4% and then by the end of the year, we were all the way up to 2.8% in terms of GDP growth. So, it was a building number, which is a trend you like to see, but some of that was related to softness related to the Japanese tsunami, which really killed the U.S. manufacturing sector in the midyear. It really absolutely killed it, and then it came back strong in the second half. So, the midyear numbers weren't as weak as they looked, and the end-of-the-year numbers probably weren't as strong. I think the 1.6 that we saw for the full year is probably pretty representative of what the year was really all about.

Now, let's look ahead, fast forward to 2012. I am thinking we are going to have better growth in 2012. I am looking at 2% to 2.5% GDP growth, and that's up from the 1.6% that I just talked about. That would almost make it "normal," if you will. So, that's the really good news there. And I think inflation will be down as well. I think we had a big commodities bubble, and I think that's begun to break a little bit. My biggest worry is that it comes back; that's the biggest fly in the ointment potentially for my forecast. So, if inflation goes nuts, all bets are off, but I really do think based on a slowing in China, slowing in Europe, and better-acting financial markets that perhaps commodities will come in just a little bit this year, and I'm looking for more like 2% instead of the 3% that we had for full-year 2011. So, that will really help out a lot.

I'm thinking employment growth of about 185,000 a month; that's not up all that much from the 174,000 last year, but it's still an improvement. And again, given that most of the growth came in the last half of 2011, a lot of that benefit of those hires will affect 2012 more than it did 2011.

I thought this looked like a wild forecast to say that we could get to 8% unemployment by the end of the year when I wrote this slide a month and a half ago, and now it looks like 8% may be in the cards.

So, those are the key parameters of what I am looking for, to give you a little bit of a feel. And again, I don't think we're going to boom; I don't think we are going to bust. But I also don't think we are as fragile and delicate as everybody says we are. If you had told me that gas prices will go from $3 a gallon to $4 a gallon, that we'd have this major Japanese tsunami, and we would have all this European debt crisis go on and still pull off the growth that we did in 2011, I don't think we're as fragile as we think we are here in the U.S. We've got a good base of industries. We've got agriculture; we've got exposures to commodities; we've got a lot of things going for us here, and I think that came up in 2011. It really showed off that maybe we weren't as fragile as we all thought we were.

As I look at [2012], I think, what's going to be big driver of it? You know, it's almost hard for it not to be the consumer, because the consumer is 70% of [the economy]. If I can leave you with one thought in this whole talk, it's that the consumer drives everything. All this nonsense about inventories and business and China and all this and that--it's really more all about U.S. consumer. That's what really drives the economy. A, he's such a big percentage of it; and B, when he makes a change, it really drives the numbers. You may hear things about inventories or even exports are about 13%-14% of the economy, versus the 70% for consumers. So, clearly what happens in the U.S. with the consumer is what really drives things, and I think the news on the consumer is good, and we will spend an awful lot of this talk discussing why I think the consumer is in better shape than most people think.

Housing, I think, is going to be a positive in 2012. It's been negative for a long time. Usually, at this point in the recovery, housing has been an important positive for employment, for growth, and it's been as much as 25%-30% of the improvement in the economy. Not this time. In fact, you will see some slides shortly that will say that the economy is still being hurt by construction spending. I think that's going to reverse itself in 2012, and that's going to be one of the big positives.

I think the balance of trade may look a little better. I think we've decreased some of our oil dependence. There was a big article in the paper today that I recommend to all of you about our less dependence on oil, and I'll talk more about that later, too, but that's the primary thing driving the improvement in balance of trade. And then I already talked about the lower inflation.

So, those are the key reasons why I think 2012 will be better than 2011.

What are the risks? I have talked about this. I said all bets are off if we have wild commodity inflation again. Almost always what stops a recovery dead in its track is inflation that gets over about the 4% level on the CPI basis. That's, again, on a year-over-year basis, not this little monthly, up two tenths of a percent or three tenths that you hear everybody whisper about. No, no, no. You've got to average a couple of months together and look year-over-year. That's the right way to look at the Consumer Price Index numbers. And on that basis, I think things will be better this year, but certainly I'm keeping my eye on gasoline prices and also commodity prices.

It also comes to the surprise conclusion that some slowing in China and Europe is actually a good thing for the U.S., because we ship so little to those countries--to give away my message later--we ship so little that it hardly makes a difference to the [U.S.] GDP. But if we spend $5 a gallon for gas instead of $4, that makes a massive difference, and right now gasoline prices are being driven by China.

One other theme that worries me--I didn't put a slide in here; I probably should have just to just talk about it. In 2011, the consumers did dip into savings. They did take up some more loans than they had in previous years to finance some of the growth. [Consumers'] incomes, when you adjust for inflation, did not grow as fast as [consumers'] spending did. So we dipped into savings. I think this year it is going to reverse, because as inflation comes down and employment has gone up rather meaningfully--and we will talk about that--those things combined will make for better incomes in 2012. But I will note, in 2011, we did dip into our savings in the U.S., and I think part of that was because the gasoline prices went up, and I think people didn't say, "Well, I'm changing my whole life because of the higher gasoline prices that we saw in July." People kind of kept spending, saying, "Well this will probably come down," which it subsequently has, and I think that's the biggest reason for that. And I think some of the income numbers may end up getting restated, too. It's a big problem in economics. Our numbers keep moving around on us; they keep getting restated.

And obviously the rest of them you're pretty familiar with. The geopolitical--what if Israel bombs Iran--is certainly an issue. The crisis in Europe, although we will talk more about that later, is a problem. And one thing to be very aware of, and I hear this, I talk to our industrials team all the time, they are definitely seeing a slowing in manufacturing outside of the United States. Some of that's related to issues in Thailand that's had a worldwide effect that everybody hasn't fully considered. Just as the tsunami had an effect on the U.S. manufacturing economy in June 2011, I think the flooding in Thailand had a huge impact on a lot of international companies. So, I think that's skewing some of the numbers, but I think China is slowing a little bit. Europe is maybe going into a recession. So, firms that get a lot of business from Europe or from China will probably see a little bit of slowing. So, that is real. But as long as it doesn't [worsen] too much more, and since manufacturing is a relatively small part of the U.S. economy, it's not going to kill us. It may kill some big companies, but it won't kill the economy.

Talking about where we are in terms of this recovery. Here I have listed on the slide for you, we've had 10 recessions and recoveries since World War II. So, this will give you a little feel … actually, believe it or not, we are 30 months into this recovery, two and a half years, and we've grown a total of 6.2%. You can see that on the very bottom of the slide, that 6.2%, which would place us right there at third from the bottom between the 1991 and the 2001 recovery. So, pretty slow recovery. It's about half the average number, so, clearly we've had that slowing this time around for lot of reasons, primarily I think housing and the fact that some would argue that this was a financial-based crisis instead of being strictly what we call an inventory based crisis, which we've seen many other times before. And so, it's been a slow recovery. That's why I had that turtle in the previous slide. So, in total in the last two and a half years, we've got 6.2% growth.

This slide is noisy. You're going to have a copy of these slides--you're going to be able to get to it on the web--that you'll be able to see for yourself. This is more of a slide to study at home, and this is to give you an idea of what drives the U.S. economy. This is looking quarter-by-quarter what are the key driving factors. And the green boxes indicate the two biggest factors in any given quarter.

So, for example, in that very first square, the 1.7%, that's what was contributed to the GDP from buying consumer goods, and that was a leading category in the first quarter of the recovery, and exports was the other big one, at 1.5% contribution to the recovery. And those numbers add up to the bottom number, which is the overall GDP growth. So, that's how you read that slide.

The far column, that … whole recovery line, adds all the way across and figures out what's been the biggest contributor for the life of the economy. So, you can see that consumer goods and exports have been the two biggest drivers of the recovery by a long shot, but you can see that's shifting around a little bit, which categories are the most important. Usually inventories are a big thing at the beginning, which we got this time and it actually helped a little bit this last time. The really key numbers are the business structures number was still a negative at 0.4%. … Usually we've had some help from business structures. The residential number is also slightly negative for the whole length of the recovery. We've almost never seen that. If you had told me we could have grown this economy at all with no growth in construction whatsoever, I would have said, "You're crazy." I think that shows the underlying power of the U.S. economy. So, again, a complicated slide, take it home. It's one to study, because it really tells you what's happening and what's important to watch.

Let me spend a moment talking about exports, because they have been an important driver of the economy. As you saw, it's the second-biggest contributor to the economy, and you'll notice it has slowed a bit in the last few quarters. It's not going to be a big contributor in 2012, in my opinion, but it has become more important in terms of the economy, and that's good news and bad news. And I've talked about a little slowing overseas, and that's why I think that percentage will probably come down over the rest of 2012, but not to panic.

Our shipments to Europe account to about 3.1% of our economy--not very much--and a lot of that is food stuff, some of it's energy-related stuff. It's not going away even if the European economy gets very weak. Maybe we'll lose 10% of our exports to Europe, unless they go into complete collapse, which would take three-tenths of a percent off our GDP--not a huge number. I think people have to understand how little we really ship to Europe and how much of it is food and things that are just not going to get cut off.

A lot of us talk about China, too. The Pacific Rim is about the same at 3.4%. If you look at China by itself, it's a measly 2%--2% of our GDP is shipping things to China, so really not very important. If China got really weak, who gets killed in this whole mess is Germany and Brazil. The U.S. doesn't really ship much to China, which probably doesn't come as a great surprise to any of you. Does anybody know what our number one export to China is? Any guesses? Exports to China? Soybeans. … Our agricultural analyst told me they actually have a decent corn market in China; soybeans, they need a little help. I had to look up. There is some word for soybeans--like oleic fatty oil or something I didn't even know what it was when I was reading the export report--and it turned out to be soybeans.

So, let's talk about the consumer that is 71% of the economy. Without them, we can't do anything. I really want you to understand why this happens, in this whole slide. This is really important. The consumer drives everything. As his spending accelerates, businesses have to increase their production, which means they have to hire more employees, which is the third thing down, or buy equipment, which is the fourth thing down.

When they do those things, that means that they have to pay those people or those businesses, and that means more income, and it comes up and there is more consumer spending, and then more production, and you get this virtuous cycle. And by the way, it works in reverse, too, when people start slowing down their spending, and then they lay off people and then they don't need any more capital goods, and you get in this cycle.

And if you think about it, it really seems impossible to stop. I will tell you, what stops this--and that's why I'm so focused on inflation--what stops the recovery is rampant inflation, and what gets us out of recession is people cutting prices dramatically to move volumes. Those are the two things that get us in and out. I think you've heard a lot about interest rates really driving things. This year, we didn't have any interest rate changes, or actually the interest rates came down a little bit in 2011. What really drove things were the changes in inflation. So that tells us--we had a real experiment here, where inflation was going in one direction and interest rates the other, which doesn't happen very often. And it really shows that inflation, not interest rates, are the key driver of the economy.

I think if you look at what happened last year, it really is pretty dramatic. So, when you have high inflation, people's wages don't go up fast enough--they can't go up, almost mathematically, to match it--and then they stop their spending, and that starts this vicious cycle in the downward path. Until people cut prices, you keep going down … And by the way, the magic number is about 4% year-over-year, that's the magic number to watch. I don't why, but it's worked in each one of the recoveries, and there are very few false signals.

So, why am I bullish on the consumer? One of the things that I like to look at is employment growth. You can see it, and I will use a fancy [economic word], the only fancy econometric word I'm going to use today, we've got this asymptotic relationship. It looks like we're approaching that 2% line. Whether we would cross it or not, I'm kind of doubting it, but we're looking at about 2% employment growth.

You always hear, you add 150,000 jobs a month, or we lose 60,000. I like to look at it as a percentage, because it gives you a feel. If you know the population is growing 0.7%, if you know a normal recovery is about 2.5%, to say employment growth is about 2% means something. So I hope this puts it in a little context for you.

We are growing about 2%, and because of productivity, we'll probably grow GDP a little bit faster than that. That's how I get to my 2%-2.5% GDP forecast. Again, you've got to be careful; at different points in the cycle, you can't use employment, you've got to use something else to help you guess at GDP, because [employment is] usually a lagging indicator, but certainly if employment is growing about 2%, it's hard for the economy not to grow 2%. It means we are saving dramatic amounts of money, which is not exactly happening.

Another employment thing--again, you hear the claims number. I tend to [look at it] as a percentage of the population, which I think puts it in better context. You can see, looking way over there on the right, we are down to 0.3% of population gets laid off every week. The best that number has ever been is 0.25%. The highest was 0.5% in this recession, so we've clearly nearly halved the rate of people we've laid off. So, I think that changes the mental outlook out there, and I think it's why people were more willing to spend in 2011, maybe even if incomes didn't keep pace--at least you had a job.

Gasoline, it really killed us in the middle of the year. You can see that giant spike to almost $4 dollars a gallon. We backed off. I will tell you, we couldn't have gotten luckier about where gasoline prices came down this year. They came right down during the holidays, which kind of boosted people's holiday spending a little bit. In addition, utility bills were low because it was warm and they could get to the stores. So we had a perfect storm of good things happen in retail for Christmas. So, that couldn't have come at a better time.

We have had a little bit of spike back up there. I'm keeping my eye on that number. Yesterday, there was some talk that the number might go back toward that $4 number. I don't think it will get there, but there is some talk that it might get close to that, especially here in Chicago, by the middle of the year, when we switch over to gasoline again, to the special blend. So, again, that's, I think, an important driver, and I do keep my eye on it. I'd rate this generally positive right now, but I've got my eye on it.

This is an interesting one. This is the financial obligations ratio. People ask, where do people get the savings money, where do they get the money to spend this year? I think this explains part of that mystery. Fixed obligations are your mortgage payment or your rent payment, whichever it is, which either you have; your car lease payment, your car rent payment; and it's your credit card payments. Those are all combined compared to your real disposable personal income in the economy. That number got as high as almost 19% at its peak. We're now down just about 16%, which is way below the 30-year average, and I'm forecasting--you will hear it here first--that I think this financial obligation ratio will hit an all-time low by the end of 2012, because incomes are going up, and … the Fed has told us that they are going to keep the interest rates low. So I think that those fixed obligations will continue as a low percentage.

So, … if you think about that, that's 4% of your income that you've now got to spend on something else. That's not fully captured in the way they report consumption numbers and GDP numbers from the government. They use something called owner-equivalent rent. They don't use your actual payments. And so this kind of misses that added thing for the economy, and this is one of the reasons I'm extremely optimistic. I think it explains why spending was so far ahead of conventional reported income in 2011. That's a lot of money.

To give you some idea, by the way, food is about 11%-12% of income--food spending. So, that's the 'whys' of why I think the consumer is doing better.

Now, let's go through some of the things. You've heard about everything being so volatile, and people being scared and this and that happening. This is weekly data from the Institute of Shopping Centers, and it's one data that I look at every Tuesday when it comes out. I race for this piece of data. I don't believe in the Michigan Consumer Confidence Survey. I don't believe in the Conference Board Consumer Survey. I watch this Shopping Center report. It's a "do as I do, not as I say" type of attitude. People when you stick a microphone or a pad in front of them, and say "What do you think?"--and if gas prices just went up or they just read a nasty headline, what you are going to say? You think "I'm not going to be stupid. I'm not going to say I am going to buy a car tomorrow, after this is out on the tape today." So, rather than [looking at] how they answer a survey about what they were actually spending, I get this data every week. It's fresher than the data that you get out of a survey, which generally takes a couple of weeks to compile.

So, I really love this number. And the good news here is the consumer has been incredibly stable. There may be a lot of ups and downs here, but they have stayed between 2.5% and 4% year-over-year growth in spending. That's darn consistent, given all … you hear about this crisis, the gas prices going through the roof. Consumers have really kind of spent right through that, and there is little bit of weekly volatility, but they continue to work in a very conservative range. I like to watch this number more than the government's consumption number or even more than the government's retail sales report. I won't go into the technical details why, but I think this is the best indicator of what consumers are really spending. So, rather than looking at the Michigan survey or the Conference Board, this is what I watch for short-term confidence.

For intermediate-term confidence, I tend to look at automobiles. You have your job for a little bit, you have to think, "I'm not going to lose my job tomorrow." So, I look at this as being the intermediate indicator of the economy. You can see, since the recovery, it's built up slowly, but this number is just at about 80.8%. So, we are at about 80% of normal right now, or peak I should say, conditions that were prevalent in most of 2005. So, I think that the autos are indicative of people having more confidence, and you can see, by the way, that that little dip in 2011 was partially due to the tsunami and was partially due to the scare over the higher gasoline prices kind of combined. So that reading has been a very good way to measure the intermediate-term confidence, and I feel good about that.

I like to look at housing starts as my long-term consumer confidence, and those are millions of units and we peaked out at about 2.1 million to 2.2 million units there in 2005. We are down to about 500,000 housing units started at the low, and now we're up to maybe about 650,000 to 700ish. So, we're up 25% from the bottom, but we're still down a heck of a lot from the 2.2 million. I don't think we'll ever see that 2.2 million again, by the way, in my lifetime, but I certainly expect better numbers than that number that you're seeing there. But we are off the bottom--maybe things aren't getting any worse there--but it still shows that consumer confidence on the very long end of the scale isn't entirely there.

One of the interesting things I find as I gave this talk, especially if I give it to a bunch of 25 and 30 year olds, as I might see at a buy side firm, the younger analyst, and I tell you, a lot of them aren't buying homes yet. There are people who have a lot of what I call optionality. I mean they have the option of living with their folks, renting an apartment, buying a home. I think probably five years ago, I'd say most of those people were probably saying, "I've got to get in the housing market. I've got to buy while I still can. I'll borrow the money from my folks, and I'll get my place now." Fast forward five years, and we've got a market where people are afraid to buy a home when they come out of school, and that's really I think what's caused the biggest slump in the housing market.
I don't think it's underwater mortgages. I think it's the young people at the beginning of the chain being unwilling to buy a home.

By the way, that can't go on forever. When people get to the age of having children, when they want to have a home of their own, they will tend to buy homes. So, I think some of the homebuying delays and attitudes towards housing we're seeing are moving more towards, right now what we're seeing, is demand deferral, which is hurting like heck, but once I get to childbearing age, you will see that spike back up in housing--not spike necessarily--but you will see an increase in the housing numbers again, that I think is pretty close to automatic. The question is "when?"

So, we've talked about the consumer, we've talked about his wherewithal--that he has got more jobs, he has got more money in his pocket because of gasoline prices, he has got better confidence both short-term and intermediate term, but he still has got that little bit of caution, and this is another reason why there is a disconnect between the economy in the U.S. doing particularly well and maybe the company is not doing as well on an earnings and margin basis.

Consumers are really fighting back at every price increase. There is a lot of data on there, but let me give you two examples that aren't on that slide just to give you a better feel. We're in AT&T territory here, so you are probably not as aware of it. But Verizon tried to tack a $2 a fee on all their cell phone bills every month if you paid by a credit card, and that got rescinded in less than a day because all of the complaints in the blogs and the fights and the bad publicity that it generated.

More locally in the Bank of America situation, I don't know if you remember, they were going to impose a $5 a month charge if you used your debit card every month. That lasted a little bit longer, that lasted about two or three weeks before that got a rolled back because all the other banks didn't follow suit.

So the consumer really has tremendous power and has really stopped people dead in their tracks from raising prices, and that's why our stocks team talks about this: You want to buy stocks with moat, stocks that have these barriers around their business, so they can raise prices regardless of what's going on, and I think it makes a lot of sense.

Here you can just see, for example, if you go down to autos, I've got the price changes, and when the price change got in May to 1.1%, volumes on cars went down 20%. So, people really reacted. Then you see down in the lower left-hand corner, we had three months of negative price change, and all of a sudden we are back at 13 million units. So, that just shows you in a big, high-ticket-price item, that people are still highly sensitive to price.

Then you go to the other end of the scale, the cheap stuff, the apparel, where the effect is more month-to-month rather than a month lag, like it is in the auto data. Prices go down and volumes go up. Now, you could see the last point on there, prices down 0.1% and volumes go up 0.7%. There is a real correlation between when prices go up and what people do.

We even see it in food, of all things. The month where grocery prices are up lot and restaurants happen to offer a lot of discounts, restaurant spending goes up and grocery stores go down. People are even making the trade off between grocery stores and restaurants, which I found incredible.

So that's what I say, consumers are really laying into corporations, and they really, in some ways, have the upper hand. Even when I was riding the train, I caught stories of people talking about, when I took my iPhone into Best Buy and zapped it, I saw the price was $2 cheaper on Amazon. So, I ordered it right there online in the Best Buy store, and I think that's the type of thing that's going on--that for now, the consumers have the upper hand.

Of course, businesses are trying to fight back. I mean, they have all marked up their list prices. They have tried to go with exclusive goods so you can't compare prices across different chains. So, they will react, but clearly this has been going on out there, and certainly you should be aware--I have seen the trend go back and forth probably two maybe even three times since I started in this business in 1981, where prices were kind of everyday low, and then you had marked-up prices but big specials, and then you went back to everyday low when Wal-Mart got so popular. And now we've kind of gotten back into it again, where you won't buy anything unless it's 40% off, right? I mean, that's how we all think. There isn't a weekend when Banana Republic or Ann Taylor LOFT or somebody doesn't have a 40% off sale, and if you were inured to not buying unless you see those prices, and I call it the "Groupon Effect." So, that's another reason for the disconnect between the economy and corporate results in 2012.

So let's talk about the surprises a little bit. U.S. oil and gas production is way up. The U.S. has actually produced more oil and gas every year since 2008. We had been on at least a 40-year type of decline. Because of new technology, the so-called vertical drilling, a lot of the techniques which work on oil and gas, there's been a dramatic increase in the amount of oil that we produce in this country. And this is a slide for North Dakota. This is just through January. I haven't gotten the last [data]. I thought maybe I'd have it for today, but I guess it's tomorrow, they will probably release the number for the next month. But it's a trend that I'm well aware of. I often take the train back to Lacrosse, my hometown, and I have a hard time getting a reservation because that train also stops at Williston, North Dakota. It's about the only way to get to Williston, North Dakota. There is limited plane service and very little housing out there, but there is a real boom in North Dakota, a real genuine boom. I mean if you want a job, go to North Dakota. They tell me, it's $15 an hour if you want to work in a Burger King in North Dakota.

Now, you are going to have to live in a trailer, because there are no homes, but there are jobs in North Dakota. When I gave this talk down in Texas, they validated that it is happening not only there, but down in South Texas too. Again, the same situation, nobody wants to really live down there.

If you want to drive a truck in the oilfields in Texas right now, you can make about $100,000 a year, and they're begging for people to come down and take those jobs. I mean it's hard, hard work, and you are going to have to live in really tough conditions. But it is out there, and the oil situation in this country has reversed. I don't think we're going to be all the way out of it--we will never have the day where we're not dependent on foreign oil--but we are getting nearer and nearer that energy independence talk. It's not just talk. Again, I recommend that Wall Street Journal article today rather than spending a lot more time on it.

By the way North Dakota now produces more oil than the State of Alaska on a monthly run rate basis, which I think is amazing.

Second big surprise, Boeing. The surprise is a non-surprise. Maybe it's the boy that cried wolf one too many times. But Boeing for years has said, "Oh, the 787 is going to ship! And look at all the new stuff it's going to have, and things are going to be great." Then there is a fire in the wiring, and then they have to redesign the wing and then it doesn't fly right. So now, when Boeing puts up these numbers--and they will give this slide any day you want--nobody believes it, because they have cried wolf. I mean, they've been saying this for the last three years, and I think this is finally the year. We've actually shipped, and the 787 is now actually in-flight on a commercial basis. They are going from two units to 10 units a months of this aircraft, over the next three years, and that's a $200 million aircraft. That will drive the U.S. manufacturing economy more than you would ever believe, and it's a huge deal, and they have now solved their latest nemesis, this labor dispute in South Carolina. They were going to produce some Dreamliners in South Carolina, and they claimed they were trying to get … to a right-to-work state and the Obama administration filed a suit and they finally solved all of that. So, they are back in gear again at Boeing, and I think that's going to be one of the surprises of the year ahead, is the strength out of Boeing and what it does to the manufacturing aggregates.

We've already talked about the automobile industry being back on its feet again, and it's really kind of dramatic. And again, what I highlight here is, this is the forecast from that date, from Automotive News, 13.6 million units for 2012. In the month of January, we did 14.2 million on an annual run rate basis, 14.2 million. I'd be surprised if, for the full year, we weren't at 14 million to 14.5 million. That's why I say it's a surprise. It's a really nice trend that we're seeing in auto.

Again, autos driving an awful lot of the manufacturing numbers, and between Boeing and the auto numbers, I think that's why the U.S. manufacturing economy in general is looking so much stronger than the economies in Europe and China, which are reporting some slowing in manufacturing--plus our wages aren't growing up as fast.

I promised I'll talk about housing. I really think it's a huge potential positive. We lost 9 million jobs in the recession. 2 million of them were directly from housing and construction--2.2 million actually. Then if you had mortgage brokers, lumber companies, mortgage processors and all that stuff, I think we probably lost 4 million to 4.5 million of the 9 million we lost, or probably about the half the total jobs, 40% to 50% of the jobs were lost due to the construction industry.

So, the fact that those haven't come back at all yet; that's the bad news. The good news is, that it's yet to come, I think. There is more to come from housing. It's typically been 5% to 6% of GDP; we're down at 1%-1.5% of GDP right now coming from housing, and I think there is a lot of room for that to come back. It's not going to come all at once, it's not going to be easy, we're going to have two steps forward, one step back, but I think we're going to get there, and it's going to be contributor in 2012. I will say that: It will be a contributor to GDP and employment in 2012.

What's the basis to that? I think we've already seen in the data, improved housing starts. There is a bunch of data out there. Existing home sales have looked a little better in a given month. Pending home sales have looked better. None of this has looked better necessarily every month altogether, but if you put them together over trend, the last three or four months have been very good. What's really killed the numbers has been the household formations.

Usually, it used to be a real simple mathematics project to figure out the housing market. Each year each age cohort is between 3 million and 4 million. The Baby Boomers at the top, is about 4 million; and the Baby Bust, which are the … guys and women that are 35 years old, is about 3 million, and that's the age cohorts, and then you figure there is about 2.2 people in a household or something. You do the math, and that tells you how many new household units you will have.

Well, that number-- the household formation--absolutely collapsed. As kids moved home after they graduated, as people got divorced and lived in place--yuck--with their divorced spouse, were very painful things that have happened in this recession. I think that can't go on forever. I think if the average family has two kids and they stay home for a couple of years, I think we're probably getting near the end of the move-in affecting numbers. I think people move out after a certain period of time. We've gone through that catch-up period, if you will, where people shifted back to living at home, and I think that's just about over, and I'm looking for that number to get better.

Homes are so much more affordable than they used to be. With 3%-4% mortgage rates and prices being down 30%, houses are almost twice as affordable as they were 10 years ago, which is just an incredible number to me. You hear so many complaints about underwater mortgages. What about people that are buying these bargains? The percentage of their incomes that have to go to housing is dramatically less than it was 5-10 years ago; I mean dramatically.

Each year there are about 75 million homes out there, and if you turn over about 5 million of those every year, that's what typically existing home sales are. We've been at this four years. I mean we've clicked through a fair percentage of the homes already at these new lower mortgage rates, and I think that's what people miss in all this. They are all focused on people who have the homes that are stuck with them and are underwater, but what about all the people on the other hand that are getting the bargains? I think that's what gets missed.

A leading homebuilder, Lennar, talked about their orders being up 20%. I think there have been some others in the last few days that have also said their order books were up 20%. There has been one or two that have had not so good numbers, but Lennar is a big major, and they've seen some good numbers.

One of the other interesting things that's out there that I think you should watch--they are talking about the government creating program, and it's even happening on its own with hedge funds and small real estate investment trusts, where people are buying up blocks of foreclosures from the banks and renting them out because there is an attractive rental market for those homes with rates being so low. That maybe will take some of the foreclosure problem away by selling them en masse to people that turn out renting them

You always hear about all these foreclosures and how it's going to create all this extra supply and how nasty it's going to be. Where do you think those people that are living in foreclosed homes are going to live? They are going to have to move into an apartment; they are going to have to move somewhere--you're not going to have people on the street, trust me on that, that's not going to happen. So these foreclosures do not really truly represent new supply, as my buddy Eric Landry in our Industrials team always tells me. So, those programs continue to move along with or without the government. I almost in some ways wish the government would stay out of it, other than to take any roadblocks away that there might be.

Again, this is a just quote from the Lennar conference call that talks about how people are coming into their units, and how even December was a great month and that's usually the worst month of the year.

Again, probably many of you have seen it. Do many people in here rent? Rent homes or apartments? My sense is that rents go up maybe 6%-8% every year here in Chicago. At least that's kind of what the statistic says. Is that kind of what you are seeing? Increases every year? Because that's what's beginning to happen, that housing prices are still sloping down just a little bit, but each year your price of rent is going up 8%. It might be kind of equal at one point, but then you sit out there two years if you kind of project 6% to 8% rent increases, the housing becomes the easy choice.

There are a few negatives. This isn't a sure deal, and that's why I've got this all in the "surprise" category. Credit remains tight, and if you missed a mortgage payment back in 2008, that still counts against you. That still may stop you from getting a mortgage by missing one or two payments by 60 days, say, in 2008. It might be just enough to do in your ability to get a mortgage, and unfortunately that has hurt.

I have talked about the foreclosure pipeline still being large and with the whole robo-signing thing that you may have heard about, where they mass-signed foreclosure documents, which was illegal, and they had to slow down the foreclosure process, while they rechecked and got legal signatures on all the documents. That's about to end or it has ended and that's certainly going to put a little bit more foreclosures in the pipeline in the year ahead, which has got a lot of people scared.

Unfortunately, the one thing that's clearly not gotten better is pricing. In the last year, home prices are down about 3% from the prior year. Now, we were down 30% from the peak, and the 3% really shouldn't be a big difference if you are planning to stay in your home awhile, and you are trying about rents going up 8% a year and so forth. But it's not like this really great investment where prices are going up a lot. So, we certainly have prices to worry about still.

But I don't know if any of you caught the article in the Tribune--it was last week sometime--it talked a little bit about home prices here in the Chicago area. And I don't know how it happened. I think you'll get a little problem with median and small sample sizes issues. But the town next to mine, Western Springs, I noticed housing prices were up 20%, or the median price was up 20%. There were at least 20 zip codes where prices were up double digits in the Chicago area in the last survey. I'm sure if you live in the South Loop or certain areas that are out in Plainfield or whatever, the number is probably considerably more awful. But it's getting to be where maybe if you are in Las Vegas, maybe if you are in the South Loop, things are really still pretty much a disaster, but now I think you're seeing certain markets doing much, much better. So you can't uniformly say housing is awful. I would put New York, San Francisco, Washington, D.C., to some degree, and some parts of Chicago even in that camp of doing better.

Anyway, it's not a perfect picture. It's not a lay up. But if there is going to be a surprise to economists, I think this is probably it, and I think the good news is that this may make the economic recovery slower than it's ever been, but it may make this economic recovery longer than it's ever been.

So with that, let me stop and take your questions.

Question: Is underemployment (or skill mismatch) still a big problem?

Johnson: Boy, those numbers all get a little tricky, and yes, there is a lot of skill mismatch out there. I mean, it is absolutely huge, and … you'll hear about this number called "participation rate"--the percentage of the population that's actually out there looking for a job, and that number probably, in this recession, came in more than it ever has, and it's been stable for about the last year. Usually by now the participation rate would have gotten a little bit better. And I think a good part of the participation rate has to do with the Baby Boomers retiring, saying, "Oh, gee, I'm laid off, I am retiring instead of looking for a job." That is certainly part of it.

Another big part of it is people going back to school instead of looking for a job, and I think that's a huge positive for the economy. And I think that's what a lot of people miss in those participation numbers is, there's a healthy chunk of those people that went back to school. Some because I suppose they had to, but I think that really is a story.

And I think the flexibility of the U.S. worker shows up again. Maybe even in this forum, I've talked about once before about Cleveland, about the number of steel workers that are now radiology technicians. It's just that the people have retrained what they're doing. Cleveland is a huge health-care market. I think the biggest employer in Cleveland is the health-care industry, in the hospitals. And the number of people that have moved from steel mill jobs into hospital jobs over the last 10 years is just unbelievable, and the number of nurses that are now guys is unbelievable. I've got two guys I work out with at the health club that were pretty hardcore laborer type guys that are now nurses at hospitals right here in Chicago. So I think it's really a pretty amazing phenomenon how flexible the U.S. workforce is.

So, yes, the participation rate is down, and yes, that bothers me, but some of it is age related. And the San Francisco Fed just recently did a nice paper on that whole phenomenon. I haven't gotten all the way through it myself, but that's certainly out there, and the retraining part of it is certainly there, and the skill mismatch is there.

Even just last night, my wife told me that they are desperate to hire a new administrative assistant at their San Francisco office, and the boss is beating on her, "Can't you find somebody to just work that office, and they literally can't find people." And we've known here for months how hard it is to find designers, certain web people, that if you want certain skill sets, then it's very hard.

And one of the other indicators is how … relatively high unemployment has stayed through all of this. Yet, I look at, yesterday, we got what's called the JOLTS Report … it's a Labor Department report. Job openings are at 3.4 million, they jumped some outrageous number, … openings jumped 10% a month, but the number of jobs didn't growth nearly as fast as the number of openings did. So that kind of tells me that you've got some of this mismatch thing going on. It's going to be hard. It's not going to be easy.

I do think some construction jobs will come back in 2012, not all of them for sure, never to the level that they were. I mean, if 2.2 was the peak, I think maybe we get back to 1.2 three years from now. So, those people are all going to have retrain or find some other profession.

The underemployed thing gets messy, and I'm never as panicked as the rest the world is [about underemployment]. If you have the people that are part-time that want full time work, and the people who will say they are discouraged, you get an unemployment rate that looks more like 16% to 20%, but keep in mind that a lot of jobs are in retail, and they do everything, as you know, in their power to keep you under 30 hours, so you don't cross into full time, and they'd have to pay all the benefits and so forth. So, as retail has become an important part of the economy, an important part of the growth over the holiday season, certainly that keeps people in the part-time boat. So that certainly hurts the numbers.

And … it's less so now, but there was even a phenomena--and I saw this in my wife's office too--where a lot of people in that firm worked part time, but when their spouses' jobs got lost or they looked … at risk, one wanted to go full-time once the other's job became more vulnerable or they lost their job. And so there were a lot of people there. And I think another part of the drop-off of people getting out of job force is that one of the two spouses found a job, and they don't need both of them working, but they had to have one of them working. So, one of people stops looking for work, and so I think that's part of the phenomena that's out there that may be the silver lining, if you will, of some of the numbers--because with two-earner families, when you have one drop out or change, it really changes the phenomena just a little bit. So, thanks for these questions.

Question: What will it take to get the younger generation to become first-time homebuyers?

Johnson: I think that's kind of the big question. I think that's a brilliant question, because I think that really is the issue. I think when housing was booming, parents were very willing to lend money to housing, because it looked like a great investment. It was a great way to get the kids started, it was a great way for you to earn a return, it was higher than a bank CD if you were a parent. And I think the parental loan market was more like a parental come-on-and-live-with-me. So I think part of it is going to depend on Baby Boomers' willingness to lend kids money for the down payment. That's going to be at least part of the equation. And maybe it's because they are sick of living with their kid, I don't know.

But that's certainly an issue. Where I hear some of the phenomena--and again, it's my day-to-day exposure, so it's not totally relevant--but a lot of buy-side analysts, the people that work in our clients' offices, are MBAs, relatively well paid, and many of them have no interest in buying a home, none. And I go and do a survey every time I go out there, and talk to a client like that, and when you talk to a group of 25 to 30 year olds with MBAs, and almost none of them have a home and some would say, "I don't want one."

So the good news is that those people, if they do ever feel like they want one, they have got the wherewithal. But you are right, the unemployment rates are a killer if you haven't got a college degree and you are in the 16- to 24-year old age gap. You are in a world of hurt. You are looking at 20% unemployment, not 5%, like the middle-aged female.

Question: Many people say that now is a great time to buy a home because of low mortgage rates; do you have a forecast for mortgage rates going forward?

Johnson: Obviously the federal reserve has talked a little bit about, in general, keeping rates low … through 2014, so another couple of years. I am not a supporter of that policy, by the way. I think that actually … makes people scared that they are seeing something in the economy that we aren't. It also takes away all sense of urgency about buying a home, or a business buying capital equipment, because if you think things are uncertain for the next two years and rates are going to stay lower for sure, why not wait until the end of the two-year period?

Personally, I think rates are going to go up, and I think they may go up--especially the longer-term rates--by the end of this year. I think that as the economy picks up a little bit of steam, that the long end of the market, which the Fed can control a little bit less than the short end of the market, the 1 to 2 year interest rates. They have to fight a little harder to control mortgage rates. They are doing it, but it's a little bit harder at the high end to do that, and I think if the economy picked up steam, they might not be able to do as much about longer-term rate. So I think rates are pretty near a low right now, unless the European banking system fails on us, which is a 10% probability, by the way, in my opinion.

So I think it's a great time to buy a home; I really do. But again, we had gotten into a situation where everybody thought they had to buy a home, and you had people that had volatile jobs, people that really had volatile incomes. Young people that really needed to have the flexibility to move cities to get a job, buying homes when they had no business buying a home. And now we're in a market where people that have a good income are going to stay in their job forever, are 28-29, not buying a home. So those are two extremes, and I think maybe as the pendulum starts to swing back a little bit, that's where we'll get the opportunity.

Frankly, I will add that the one issue about homes, too, is actually finding a nice home right now. I think there is not a lot of inventory out there, and a lot of foreclosures are beat up. And a lot of people--because it's their second home, because they are retiring and they want to move somewhere else, they're casual sellers, if you will, and because the prices aren't right, the homes aren't on the market. So you may not find the best houses in the world right now, and I think that's the unfortunate thing about the low prices right now.